"Independence is a state of mind - you just need to keep an open mind and consider all the options", the Financial Conduct Authority (FCA) said as it summed up the findings of its latest post-Retail Distribution Review (RDR) research.
The regulator has published the first part of stage two of its thematic work into the Retail Distribution Review (RDR), saying most IFA firms were now compliant but some were still not sticking to its rules on independence.
Here is a round up of the good and bad practice the FCA found in firms during its investigation, broken down by areas of concern.
Providing advice on all retail investment products (RIPs)
The FCA reiterated it required IFAs to be "prepared, willing and able" to provide advice on all types of retail investment products (RIP) that may be suitable for their clients. It said it did not expect firms to actually recommend all products but they must consider all the options for their clients.
As an example of good practice the regulator illustrated how one firm was helping its advisers research the whole of market for each RIP.
"Rather than simply telling advisers that they should consider all RIPs then leaving them to do this on their own, the firm had made a significant effort to provide [all of its advisers] with the tools to help them do so," it said.
Poor practice, on the other hand, involved a firm which featured an adviser who advised on all products but was unwilling to recommend structured investments because he did not fully understand the products and how the underlying investments worked.
The FCA agreed the adviser should not be advising on these products in the circumstances but consequently should not call himself independent, it said.
"This adviser should not hold himself out to be independent as he does not have the knowledge and ability to identify if a particular product type is potentially suitable for a client," it said.
Another example of bad practice was a firm which advised on all investments other than annuities - they referred clients to another firm specialising in annuities instead.
"As this firm was not willing and able to advise on all RIPs in practice it did not meet the independence rule," the FCA said.
The regulator said key points to consider on RIPs were whether each adviser in a firm is able and willing to advise on all products and whether some products, that may have been 'excluded' in the first instance as they were deemed unsuitable for all clients, were reviewed on a regular basis ‘keeping an open mind'.
What is a ‘relevant market'?
The FCA defines a relevant market as ‘all retail investment products which are capable of meeting the investment needs and objectives of a retail client'.
An IFA can identify a narrower relevant market across all of its clients and still act independent, but the important thing is that it's about what the clients need not the product groups the adviser chooses to favour.
The FCA's examples of where a relevant market may be applicable are: ethical investments, Islamic financial instruments and pension decumulation.
As poor practice, the FCA identified a discretionary investment manager (DFM) which considered itself independent advising on what it referred to as ‘investments'. But the FCA found the firm did not include life and pension contracts.
It said: "This did not meet the definition of the relevant market as the products it advised on were not focused on the clients' needs and objectives but rather product categories."
Referrals to another adviser
The FCA says every adviser in an independent firm must be willing and able to advise on all RIPs. They cannot refer clients on to colleagues for particular product areas they don't feel comfortable with.
However, it is possible for an adviser to seek expertise from another adviser as long as they are in a position to provide the final advice to the client themselves.
Good practice was found in a firm that had an income drawdown specialist to help out other advisers where needed but where all advisers had sufficient knowledge to identify when a client would potentially have the need for income drawdown.
They were able to provide advice to clients, but typically sought additional support from the product expert.
Bad practice was where a firm had a licensing agreement with some advisers for certain high risk products. Where an adviser identified that a client had a need for a product that he was not permitted to advise on, he would refer the client to another adviser in the firm.
This system would have been deemed independent advice had the firm permitted the adviser to recommend the high risk products subject to a pre-sale suitability assessment.
The FCA says it is possible for a firm to use a panel and remain independent so long as the panel has been constructed based on a review of the whole of the market and the advisers keep an open mind and consider all options for clients where an on-panel solution is not suitable.
Panels should be constructed depending on a firm's client base and should be reviewed regularly and all advisers must still be aware of the whole rest of the market.
An example of bad practice was a firm that used a panel and said it was open to the whole of market but its advisers were found to be unsure of how they would do this in practice and did not appear to have access to any tools to help with this.
Similarly to panels, platforms need to be used with the whole of market in mind. The FCA also reminded firms they needed to perform checks on their platform to make sure it presents RIPs without bias and that "the platform provider only receives remuneration for business carried on in the UK that is permitted by the rules".
The FCA said it was unlikely IFAs would be able to use a single platform.
It found one firm was using a single platform for clients it considered to have similar circumstances. But on further investigation it saw that the firm also advised the children of their main clients whose needs and circumstances were very different, using the same platform.
Using one platform for the majority of clients, complemented with off-platform solutions, is a more likely scenario for IFAs, the FCA said. But the platform adopted would need to be competitive in terms of charges and features for this to be an appropriate approach, it added.
A firm where this approach worked had recommended an off-platform SIPP to a client when the platform-based SIPP did not offer the option of individual commercial property purchase (or SIPPs available through the platform were uncompetitive in this respect) when this was deemed suitable for the client.
In contrast, another firm was found to have used a single platform but had not assessed for which clients the platform-based services were - and were not - suitable.
When adopting a single platform for only some clients a good practice example was: Firm L had decided it wanted to provide a ‘premier service' to clients over a certain level of investable assets. It had undertaken appropriate due diligence on which platform to adopt and considered which clients this approach would be suitable for, and which it would not.
"Although this service and the platform used to underpin it proved to be suitable for most clients within this defined segment, it did not adopt a ‘one-size-fits-all' approach," the FCA said. Off-platform products also continued to be considered. The firm was therefore following RDR rules.
Bad practice when using multiple platforms included a firm which saw its advisers adopt different platforms from each other and failed to come up with a consistent approach for servicing clients.
"There was no clear understanding by advisers, or the compliance officer, about when their platform-based services were suitable and not suitable. This risked unsuitable advice," the FCA said.
There was also the potential for costs for clients to be higher than would have been had the firm used platforms in a more focused and economic way, it added.
The FCA defines model portfolio as ‘a collection of funds with a certain asset allocation typically designed to meet a specific risk profile'.
Same as with platforms, independent firms need to ensure their model portfolios are constructed ‘based on a comprehensive and fair analysis of the relevant markets' and should not use the portfolios without considering the needs of the individual clients. Again, they should stay open minded about using other products if deemed suitable.
An example of bad practice flagged up by the FCA involved a firm which built its own model portfolio to suit its current clients. When asked how they would deal with a new client that had a higher attitude to risk, they explained this had not happened in the past but if it did, they would likely refer them to another adviser.
The FCA said: "This firm thought they were meeting the independence requirements as they had built their model portfolio from assessing all investments in the market that were suitable for cautious investors. However, they had then restricted their advice by not considering other options for clients when appropriate."
Discretionary investment services
The RDR independence rules do not normally apply if an adviser is referring a client to a discretionary investment management service because the recommendation is typically for a service rather than a RIP.
However, there are certain circumstances where the advice does constitute a personal recommendation in relation to a RIP and the independence rules do apply.
The FCA said firms should objectively consider a wide range of investment solutions in the market before recommending a client use a discretionary investment service. They should also consider the client's needs for such a service.
An example of good practice was found in a firm that had advisers as well as its own DFM service. The FCA found the advisers were free to choose whether they wanted to recommend a DFM and if so, which one.
The firm had carried out a market review and created a short-list of approved discretionary managers to help, but advisers could use other firms if they wanted to, subject to their research being approved centrally.
The firm was able to provide examples of cases where advisers had recommended discretionary investment managers other than the associated firm, the FCA said.
Poor practice, on the other hand, was found in a firm that had been referring clients to the same discretionary manager for a number of years.
They had found that the service provided by the firm had been very good and existing clients were very happy with the management of their investments. So the firm felt no need to review the choice. This did not comply with RDR independence rules.
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